| Greetings!
This issue addresses the problems 401k vendors have. No not all 401k vendors. Just the ones that push their own proprietary investments. We also at the end of the story award the first annual Ok401k "Hotel California" mutual fund award for the Decade! This award goes to the fund that does something no other fund can do over a 10 year period. Check out the bottom of this story.
What do 401k providers Fidelity, American Funds, Principal and local Oklahoma powerhouse banking giant Bank of Oklahoma all has in common? All four along with many other mutual fund and insurance company 401k vendors push proprietary funds inside the 401k plans they sell. So, how do they stay objective when providing an inventory of funds including their own to the employer groups that select them for 401k recordkeeping? They don't have to because as a 401k vendor, they have no fiduciary responsibility to you as the employer. In fact, any 401k provider pushing their own funds can put the worst performing funds with the highest fees in your plan and unless you figure it out, they are laughing all the way to the bank. Ever hear the story of the fox watching the hen house? The trouble with this problem is that most plan sponsors (employers), when circumventing an independent 401k advisor, have no idea about the potential conflict of interest their bank, insurance or mutual fund 401k vendor may have and the precarious fiduciary situation using these vendors can put them in.
Take for example the retail world. When you buy ketchup at a Wal-Mart Super Store which ketchup does America's retail giant want you to buy? Wal-Mart Shelf Managers are not any dummies when it comes to selective shelf placement of their own proprietary product. Late at night when we mere mortals are sleeping the Wal Mart shelf people are conveniently placing next to America's top selling ketchup Heinz, Wal-Mart's own private label ketchup which of course just happens to be conveniently priced at probably 20% or 35% less. Do you think Braums Ice cream in Oklahoma stores will be selling Ben and Jerry's Tootie Fruitie in the near future? How about Starbucks stores selling locally developed Java Daves coffee in Oklahoma? That will be the day when Southwest Oklahoma State football team out of Weatherford, Oklahoma knocks off the OU Sooners in Norman. Aint gonna happen. The same profit motive that dominates retail stores' shelves exist in 401k plan store shelves that supposedly have ALL of the best funds available. Employers are reassured that they don't have to worry about looking anywhere else for fund selection because their bank, mutual fund or insurance company vendor has all they need. You, as the consumer (401k participant), may get screwed in the process for not enjoying access to the top selection of growth or international funds simply because the 401k vendor may not show you the entire world of funds available. Is this process a best practice for an employer's fiduciary responsibility? If your 401k committee is picking and monitoring the fund performance whose criteria are you using? Is it only the bank, insurance or mutual fund company's criteria you hired to administer your 401k plan?
Do you want to know how to make money in and up and down markets? Do you want to know how the secret to all-weather profits? Would you like to collect millions of dollars, even in the worst bear market since the Great Depression? Easy. Run a mutual fund and that is what the banks, insurance and mutual fund companies have figured out when pushing their own funds to 401k participants thru 401k plans. The fund management business can be very profitable indeed, particularly for extremely large funds. For example, Lipper lists 30 stock fund share classes with assets greater than $10 billion. The average expense ratio for those funds is 0.548%! Collectively, those 30 funds will collect (again, roughly) $3.9 billion in fees the next 12 months even if the fund is going downhill and your participants in a 401k plan are simply losing their shirt. So, if you own a mutual fund and you want to get people to buy it even if it's a stinker, own a 401k recordkeeper! And, you have struck gold cause who is going to question the quality of your mutual funds in the 401k plan if your bank may be the leading lender in the community?
Let's take a look at 401k giant Fidelity which sells a ton of 401k plans without a real professional advisor involved (Fidelity Direct). Would a Fidelity Direct sold 401k plan consider offering American Funds Growth Fund of America to their 401k customers instead of their own Fidelity Growth fund? Which fund do you think 401k giant Fidelity makes more money on? To make things easy for you, hell will freeze over before you will ever find any American Funds inside a Fidelity Direct recordkeeping run 401k plan. It's sort of like a rivalry not seen since the Hatfields and the McCoys were shooting at each other or General Grant versus General Lee 150 years ago. The same holds true for select American Funds 401k plans. You won't see any Fidelity funds offered inside their Recordkeeper Direct sold 401k plans even if some of the Fidelity funds have turned in a better performance over the long term. These cold wars do nothing for employers who sponsor a 401k plan and don't understand these mini turf battles going on behind the scenes which can put their Investment Policy Statement (IPS) in jeopardy of legally being challenged by some hot shot ERISA attorney.
One key example that is as clear as the frost on a Halloween pumpkin is when 401k vendors pushing their own proprietary funds are offering clear underperforming DOGS. Our Dog House focus today is on Bond Fund of America sold by American Funds. We see Bond Fund of America in quite a few American Funds 401k plans, especially their boutique small plan model called Recordkeeper Direct pushed by many TPAs across America. We ran Morningstar data on the Bond Fund of America, R5 share class RBFFX, over a 3 year period. This fund has been in the lower performing 11th percentile. This means according to Morningstar that out of over 800 bond funds, approximately 600 competing bond funds, outperformed American Funds Bond Fund of America during that period of time. * Yet, we find this proprietary Bond fund all the time in the American Funds 401k plans we review in Oklahoma and outside of the state. Are the employers we talk to just drinking American Funds Kool Aid and not being informed about other bond fund choices out there that may have a better performance record?
By the way, the Bond Fund of America can be bought in the R5 share class for your employees at a reasonably priced expense ratio of only .37 basis points yet we see many Recordkeeper Direct 401k plans with the much more expensive American Funds Bond Fund of America R2 share class at 1.49% expense ratio. Higher investment fees mean the 401k participant in the very same fund has less money at retirement. Why are these employers not asking their advisor to be in the R5 share class which means potentially more money for the participant? Should an employer be concerned? 401k participants will suffer in the long run simply because the fiduciaries are not offered access to the entire universe of funds out there by the broker or 401k vendor. Which leads us to who is watching the hen house? Is it the Fox who may be your 401k provider or your advisor who can make more money on the R2 share class rather than the lower share class funds? You as the employer have to question how are funds reviewed, selected and deleted. Which also leads us to the tools used to monitor the funds you have in your 401k plan.
Employers should have a 401k committee and either using an advisors' investment monitoring tools or their own. These fund review tools enable the employer to have a criteria and a process in place which governs the selection and monitoring of the 401k investments in the plan. Smart employers hire independent investment advisors who perform this review which covers the appropriateness of each investment choice and what fund stays and what fund goes. Think of Attila the Hun in a business suit with all the investment data to back them up and looking out for you and the 401k committee. ERISA recommends (the law) that if the 401k committee does not have the training or tools to do this investment review process, they should hire an independent professional. We still see employers trusting their 401k vendor and not getting a 2nd opinion. This leads us to the decision to eliminate a poor performing dog of a fund from your 401k investment line up. Let's say in a hypothetical review, you discover that the Barking Dog Fund that has nothing but manufacturers of pet food products in its fund portfolio is dead last in its Morningstar category for 10 straight years. And in this hypothetical scenario you decide that the Barking Dog fund is not a good choice for your employees? Unfortunately, you discover this fund is owned by your 401k provider. Will they give you that right to select a better performer that may not be their fund? If you want to shoot the dog, how much freedom do you have to replace it with a top performer?
John Waggoner, top financial writer for USA Today recommends that a mutual fund should be removed when " in most cases, a manager who can't beat the majority of his competition over three years gets shown the door." And, John further advises "If your fund company won't show them the door, you should." Think there may be a conflict of interest when the 401k vendor owns their own proprietary funds inside YOUR 401k plan and won't show them the door? Ok401k has seen tons of examples where employers that have their plan with 401k vendors pushing their own proprietary funds are not given all of the information they need to make a proper fiduciary decision on what funds should stay and what funds should be shown the door. You don't have to accept a 3 year criteria on fund performance. It can be 5 years or 10 years. No matter what, the 401k committee needs written criteria (IPS) to evaluate the investments offered to your employees.
Back to the lower fee issue. We never recommend cheaper is better but if you can get the same funds at a lower share class? Why not? I encounter employers that manage their own 401k plan that don't even know that they can buy the American Funds Growth Fund of America at an R5 share class RGAFX with an expense ratio of only .40 basis points when their employees are investing in an R2 share class at 1.48% expense ratio. That is an extra 1.08% in expenses. Would you buy a 30 year fixed mortgage at 4.5% or 3.5%? The same laws of economics that exist in your home mortgage exist in your 401k plan. Employers don't know that you can negotiate the share class fees your employees pay to invest.
Let's take a look at Bank of Oklahoma. Ok401k recently provided a large employer with an independent review of their 401k plan investments currently managed by BOK. Great bank and I used to have my mortgage with them. Do they give their own BOK proprietary funds a passing grade when comparing them to the appropriate Morningstar peer group? What is the problem you have as an employer if a 401k provider keeps their own under performing fund on your 401k menu and allows your employees to keep investing in it? You be the judge. Our review of this particular employer plan with over $15 million in assets in the 401k plan revealed there were two balanced fund choices. One of the balanced funds was BOK's Cavanal Hill Balanced APBAX with a net expense ratio of 1.06%. The Cavanal Hill Funds are managed by the investment professionals at Cavanal Hill Investment Management, Inc., a wholly owned subsidiary of Bank of Oklahoma, who, along with its other affiliates, is part of the regional bank holding company BOK Financial Corporation. Interesting enough the 401k plan also offered to this employer another balanced fund choice managed by Dodge & Cox DODBX with a very cheap .53% basis points expense to the employees. The Dodge & Cox Balanced fund, according to Morningstar, creamed the Cavanal Hill Balanced proprietary fund by twice the returns over a 10 year period as compared to over 344 other balanced fund family competing choices. We're not talking short term period here! We're talking 10 years! For your information the top performer for 10 years in the Balanced category from Morningstar was the FPA Crescent mutual fund, FPACX. PFA Crescent trounced both of these fund selections in this plan. Hmmm, do you think this 401k committee may have a problem if they allow this BOK balanced fund to stay on the 401k menu and continue to allow their employees to contribute? Now this particular employer probably does not have a problem if their Investment Policy Statement says that it's okay to offer funds choices that under perform their peer group or will have higher fees then an equivillent peer fund over a 10 year period. You just have to, as an employer, have a written Investment Policy Statement spelling out what the criteria are and how you pick and monitor funds. I suspect that this local Oklahoma 401k committee without the services of an independent investment advisor had no idea that they are the ones responsible to tell BOK to add or delete any poor performing investments not BOK because they probably have not signed on as a fiduciary to the plan.
And finally we come to Principal Life Insurance Company, one of America's finest life insurance vendors. In honor of Glenn Frey, lead singer of the Eagles, our Ok401k "Hotel California" Award for the Decade goes to Principal Life Insurance Company investment choice called the "Principal US Property Account." The award each decade goes to the 401k vendor pushing their own proprietary fund that not only loses a ton of money but incredibly, does not allow the participants to get their money out! That is why we have the reference to Hotel California. You can check in but you cannot check out! Hmmm, you think the 401k committee (employer) has a fiduciary problem if they allow an investment in the 401k plan and the employees cannot get their money out when they want?
This investment is called the Principal U.S. Property Account. It's Principal's own proprietary fund and it's sold in a group annuity contract. Interesting enough, Principal also sells a wonderful real estate mutual fund that is ranked high by Morningstar and has liquidity so why did Principal not offer 401k participants this "real" to performing mutual fund with no liquidity issues in their 401k insurance plans they sell nationwide? If you have Principal as a 401k vendor you may have this separate account offered to your employees in your 401k plan. Principal was as of earlier this year being sued. The complaint was received in the United States District Court Southern District of New York on December 4, 2009. Ok401k notified over 4000 of our readers of our widely read email newsletter across America in autumn of 2008 that we thought that the actions of Principal were not in the "spirit" of ERISA and the many employer groups they serve across America. It is our position that employees should not be hindered from moving money inside their 401k plan to any investment choice they desire without penalty.
During the real estate melt down of 2008, Principal decided to send a letter to all 401k participants that had this separate account on September 26, 2008. The letter said "you cannot liquidate your money out of this fund and move it into another fund." Like the passengers on the Titanic, 401k participants were instructed that they had to stand in line in an orderly fashion and wait to disembark while the ship slowly sank. The lawsuit asserts that the per share value on September 26, 2008 was $704.32 and as of November 30, 2009 it was $443.98. The complaint further states "Contrary to its statements about the Real Estate Property Account's low-risk profile and strong focus on liquidity, Principal's investment practices maintained insufficient liquidity in the fund to meet daily withdrawal requests, which was imprudent in light of the Fund's stated objective to incredibly........maintain liquidity."
So, Ok401k's Hotel California Fund Award for the decade is given to Principal's US Property Account because, you can check in but you cannot check out! Hopefully these stories will provide you and your investment committee with insight into the games that 401k provider play when they push their own home cooking. Wait until we address guaranteed accounts pushed by insurance company vendors and money market funds by mutual fund 401k providers soon in our next issue. Think all money market funds or guaranteed accounts are the same?
You can check your 401k funds' performance against its peers at www.morningstar.com or make it easy on your busy schedule and ask for an independent comparison of your plan funds and fees from an independent fiduciary 401k advisor like Ok401k. We can knock out an Fi360 comparison of your funds with their equivalent Morningstar peer group. We can also compare your Investment Policy Statement with thousands of employers that have one also. Best part of it all? There is no cost or obligation and it's completely confidential.
· As is with all investing, past performance is not indicative of future performance.
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